Tax Reform That’s Pro-Climate and Pro-Economy?

, Policy Director and Lead Economist, Climate & Energy | October 5, 2011, 12:36 pm EDT
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A recent article in the National Journal has been generating a lot of buzz. Understandably so, because it makes clear that climate change should not be viewed as a partisan issue and that thoughtful leaders on both sides of the aisle recognize the importance of good science.

The article quotes George Shultz, President Reagan’s Secretary of State, saying: “My own opinion is that this problem is very real. I recognize there’s a lot of people pooh-poohing it. Whether they like the science or not, there’s a huge problem coming at us.” Of Republicans like presidential candidate Governor Rick Perry who deny climate science, he said, “They’re entitled to their opinion, but they’re not entitled to the facts.”

A Carbon tax as part of a tax swap

Tax bads not goodsWhat also piqued my interest is some economics that’s buried in the article. To move forward on addressing climate change, the article mentions that: “one proposal that has long been embraced by conservative economists, for example, is a tax swap—imposing a tax on carbon emissions, while eliminating the payroll tax.” It goes on to mention general support for these kinds of ideas from environmental groups as well.

In an era of a severe budget crisis compounded by a deep economic recession, a tax swap seems like an attractive way to open the door to putting a price on carbon and simultaneously providing tax relief to Americans. There’s also beauty in the logic of taxing a “bad” (pollution) and rewarding a “good” (labor).

Caution on eliminating payroll taxes as part of a tax swap

However, my own view is that we should be very careful of any proposal to eliminate or sharply reduce the payroll tax as part of such a tax swap. This could have a severely destabilizing effect on social security and Medicare, which are funded through payroll taxes. Revenues from a carbon fee cannot be well-calibrated to the U.S. demographic profile or the actuarial profile of retirees so there is no way to guarantee that such fees can adequately fill the revenue gap once payroll taxes are gone. Furthermore, it is quite possible that the congressional appropriations process would add uncertainty to the amount of the carbon revenues that would be available to fund social security and Medicare versus other politically attractive programs and projects. Finally, the social contract and sense of collective “buy-in” that is a crucial feature of social security and Medicare could break down if they are primarily funded from sources unrelated to worker and employer payroll.

Other tax swap proposals

A 2007 paper by Gilbert Metcalf (now the deputy assistant secretary for Environment and Energy in the Office of International Affairs at the Treasury Department) lays out a more moderate version of this idea, which he calls a Green Employment Tax Swap (GETS). His proposal is to levy a tax of $15 per metric ton of carbon dioxide (CO2), which would then be used to rebate the federal payroll tax on the first $3,660 of earnings per worker. Metcalf shows that this program could be designed to be both revenue-neutral and distributionally neutral. A tax of $15/ton CO2 will by no means be enough to sufficiently lower carbon emissions, but at least this proposal is more fiscally responsible in that it does not call for completely eliminating the payroll tax.

Another option could be to cut personal income taxes, instead of payroll taxes. This could be set up as a progressive tax cut or even a refundable tax credit so that low-income families that may be disproportionately affected by rising energy costs (or by the impacts of climate change) could be compensated.

And of course there is a school of thought that a price on carbon should exist in its own right (to make explicit the costs of climate change caused by carbon emissions) and not be coupled with any tax cut. In that case, the revenues could be used for any number of useful purposes – such as funding for renewable energy and energy efficiency, rebates for low-income families, worker training programs, funding for international mitigation and adaptation efforts, or even to offset the budget deficit.

Breaking through the political impasse on climate policy

All of these proposals may seem like mere pipe dreams today. But as an economist who is very concerned about the grave risks posed by climate change, I welcome any glimmers of hope that we may yet find a way to put a price on carbon in the U.S.

Do you think a tax swap proposal could break through the partisan wrangling and move us forward on pricing carbon? What taxes, if any, do you think should be cut while raising carbon revenues?

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  • Bob Fusinato

    The Tax swap proposal is a bad idea for a number of reasons. First of all, it is nothing more than a scheme to eliminate Social Security and an extremely disingenuous one at that.

    The payroll tax is a dedicated income stream that funds current Social Security payments and up till now has been building up the “trust fund”. It is what keeps Social Security “off budget” and secure. Given Congress’ record of passing budgets lately, it is likely that putting Social Security on budget would do inject a lot of uncertainty into the economy in the short run. In the long run, it could lead to its elimination.

    Second, we have already been reducing taxes over the past 10 years and it looks to me like that policy has been more effective in driving up deficits than generating new jobs. Furthermore, consumer driven recoveries have proven to be unsustainable and really undesirable from the standpoint of environmental quality. The more we consume the harder it is to reach environmental and resource sustainability goals.

    For many reasons I believe that the 21st century will be marked by increasing competition for dwindling resources. If we take that as a challenge to fund programs to improve efficiency and transition to renewables, it will do a better job of sustaining economic growth than short term stimulus measures.

    I do think that a well thought out carbon tax program is a viable approach to reducing green house gas emissions and other harmful effects of fossil fuel use. But I would put that money into funding alternatives and possibly reducing consumer costs.

    • Thanks for your comments, Bob. I think you point out some valid concerns with a tax swap that cuts payroll taxes.

  • Marcello Petrigh

    Application of the tax on carbon emission should not be coupled with any tax cuts.